CalPERS slams San Bernardino for 'sham' bankruptcy

A high-stakes legal battle has intensified as the largest U.S. pension fund filed court papers denouncing the financially troubled city of San Bernardino for what it called a "sham" bankruptcy and accused the city of "criminal behavior" in withholding payments to the pension plan.

The filing on Friday by the California Public Employees' Retirement System, or CalPERS, came 10 days after San Bernardino officials traveled to Sacramento to plead with top CalPERS executives for more time to make payments.

At issue is whether the pensions of government workers take precedence over other payments in a municipal bankruptcy - which could have ramifications for municipal creditors, including Wall Street bondholders, as more cities and towns have trouble meeting their obligations.

No agreement was reached at the CalPERS-San Bernardino meeting, and CalPERS officials told Reuters they have little latitude to allow San Bernardino - or any other city that pays into its pension fund - to alter the payment schedule.

San Bernardino officials, for their part, say they also have no alternative - and sorely wish they did.

"Why would anyone put themselves through this level of pain - daily, recurring pain - to perpetrate a sham?" asked City Attorney James F.

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Penman. "You couldn't do that and be in good control of your mental faculties."

Penman said he hadn't yet seen CalPERS' most recent filing, but the bankruptcy is filling the minds of city officials.

"For CalPERS, it may be just another issue - we're one of hundreds of cities they have - but for us, every day that we go into work, every night that we're sitting at home thinking...there's an umbrella of sadness over us," he said, noting he met to discuss the bankruptcy Saturday with two City Council members and planned to meet Sunday night with Mayor Pat Morris. "These decisions are made after a lot of thought and usually a lot of dialogue, and for some of us a lot of prayer."

In a closely related action, bond insurers who are responsible for the debt of Stockton filed papers in that city's bankruptcy case denouncing CalPERS' efforts to be treated differently from other creditors. Stockton has continued to make payments to CalPERS while halting payments to some bondholders.

Both cities filed for bankruptcy in the wake of the housing market bust and years of financial mismanagement, and the two comparatively rare municipal bankruptcy cases are expected to set important precedents as to who gets paid when a government goes broke.

But while Stockton was well prepared when it filed for bankruptcy protection in June, San Bernardino's finances and government operations are in deep disarray as political factions battle one another, according to an ongoing Reuters investigation. The city filed for bankruptcy on Aug. 1 with no plans as to how it would meet its obligations.

CalPERS, which manages $241 billion in assets and serves many California cities and counties, said in its legal filing that San Bernardino appears to have been operating for more than a decade without necessary financial controls and lacks even basic mechanisms such as monthly cash-flow reports.

CalPERS said San Bernardino's proposed plan for operating in bankruptcy, filed last month, was "no plan at all."

"It is merely an attempt to buy time, at the expense of CalPERS and other post (bankruptcy) petition creditors," CalPERS said in arguing the city was not entitled to bankruptcy protection. CalPERS has already filed actions in state court, which could end up arbitrating the situation if bankruptcy protection is denied.

CalPERS accused the city of "criminal" conduct for not making pension payments that are part of employee compensation agreements.

In markedly aggressive language, CalPERS said the city had "buried its head in the sand," rather than deal with a long-standing financial crisis.

"The city gravely needs to get its house in order... Ten years of history suggest that the city is not going to implement meaningful change until forced to do so. This court needs to hold the city's feet to the fire."

San Bernardino is broke and can barely make payroll, city officials have said. It has not made its $1.2 million biweekly payments to CalPERS since the bankruptcy filing and now owes at least $8 million, in addition to a long-term debt to the fund that the city pegs at $143 million.

CalPERS argues that under California law it has primacy as a creditor, asserting that it is in essence an "arm" of the state and must continue to be paid in full, even in a bankruptcy.

Wall Street bondholders and insurers vehemently disagree, arguing that federal bankruptcy law trumps state authority and should allow them to fight with CalPERS in court as equal creditors.

Both sides have told Reuters they are willing to fight this issue all the way to the U.S. Supreme Court, which could take years.

In San Bernardino, the first city ever to deliberately halt payment to CalPERS, city officials are in a desperate scramble.

According to CalPERS officials, the meeting was cordial and the city officials stressed that their plan to defer payments is made in good faith.

But in its court filing Friday, CalPERS alleged just the opposite, accusing the city of acting in bad faith in failing to propose a viable plan to meet its obligations.

CalPERS officials say it is highly unlikely they can accede to any proposal to defer payments.

"CalPERS does not have the power to 'negotiate' the amount of employer contributions owed by the city," Peter Mixon, CalPERS' general counsel, told Reuters. "The city of San Bernardino cannot alter the requirements of state law."

San Bernardino's acting city manager and finance director, both selected shortly before the city announced it planned to file for bankruptcy, did not return calls Friday.

But both have pointed to past decisions they say led to insolvency and said that since then the city has made substantial cuts and meaningful change, including 30 percent reductions to most city departments.